A:

An account liquidation occurs when the holdings of an account are sold off by the firm in which the account was created. In the majority of cases, this will deal with problems arising with margin requirements. When you sign up for a margin account with a brokerage firm, that firm obtains the legal right to liquidate your account when you are unable to meet the account's requirements.

There are two main account types: cash accounts and margin accounts. A cash account only allows an investor to purchase securities up to the amount of the cash held in the account. For example, if an account has $10,000 in cash, the account holder will only be able to purchase a maximum of $10,000 worth of stock.

With cash accounts, a brokerage firm does not have the same ability to liquidate unless it is in regards to an external factor like a personal bankruptcy. A margin account, on the other hand, allows investors to borrow money from a brokerage firm on top of the money they have placed in the account, usually up to 50%. Therefore, if you have $5,000 in the account, you could potentially purchase $10,000 in securities.

A typical requirement of a margin account is to maintain at least 25% equity, or your own money, of the total market value at any given point. For example, suppose you purchase $10,000 worth of stock with $5,000 of your own money and $5,000 of margin money. If the value of this position were to fall to $7,500, your equity position in the investment falls to $2,500 ($7,500-$5,000), which represents 33% margin - above the 25% requirement.

However, if the value falls to $6,500, your equity in the position would be reduced to $1,500 ($6,500-$5,000), which puts your margin at 23%, falling below the minimum margin requirement of 25%. If the account does fall below the minimum maintenance margin level, you will either have to add more money to the account to meet the margin call or your account will be liquidated in part or in full.

For more information, read the Margin Trading tutorial.

RELATED FAQS
  1. What happens if I cannot pay a margin call?

    Minimum margin is the amount of funds that must be deposited with a broker by a margin account customer. With a margin account, ... Read Answer >>
  2. How much can I borrow with a margin account?

    Understand the basics of margin accounts and buying on margin, including what amount investors can typically borrow for purchases ... Read Answer >>
  3. What does it mean when I get a maintenance margin call?

    Understand how maintenance margin calls work, and learn about how margin requirements are different for trading stock versus ... Read Answer >>
  4. How exactly does buying on margin work and why is it controversial?

    Learn how purchasing stock on margin works, and understand the risk associated with margin accounts that make the strategy ... Read Answer >>
  5. What's the difference between a cash account and a margin account?

    Compare and contrast margin and cash accounts. Margin accounts offer short-term loans, leverage on existing portfolios, and ... Read Answer >>
  6. What are my options when I get a margin call?

    Understand what a margin call means and the two primary options for meeting a margin call, such as depositing additional ... Read Answer >>
Related Articles
  1. Financial Advisor

    Understanding the Maintenance Margin

    A maintenance margin is the minimum amount of equity that must be kept in a margin account.
  2. Investing

    Buying on Margin

    When an investor buys on margin, he or she pays a portion of the stock price – called the margin -- and borrows the rest from a stockbroker. The purchased stocks then serve as collateral for ...
  3. Trading

    Pick the Right Brokerage Account for Options Trading

    Follow these steps to pick the right options brokerage account depending on your trading needs and style of trading.
  4. Trading

    Introduction to Margin Accounts

    Find out what your broker is doing with your securities when you invest on margin.
  5. Investing

    Explaining Initial Margin

    Initial margin is the percentage of a stock’s price an investor must have in his account to buy that stock on margin.
  6. Investing

    What Is A Trading Account?

    A trading account enables an investor to buy and sell securities.
RELATED TERMS
  1. Margin Account

    A brokerage account in which the broker lends the customer cash ...
  2. Remargining

    The process of bringing an account up to minimum equity standards ...
  3. Buying Power

    The money an investor has available to buy securities. In a margin ...
  4. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin ...
  5. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions ...
  6. Initial Margin

    The percentage of the purchase price of securities (that can ...
Hot Definitions
  1. Marginal Utility

    The additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important ...
  2. Contango

    A situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation ...
  3. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  4. Acid-Test Ratio

    A stringent indicator that indicates whether a firm has sufficient short-term assets to cover its immediate liabilities. ...
  5. Floating Exchange Rate

    A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that ...
  6. Taxes

    An involuntary fee levied on corporations or individuals that is enforced by a level of government in order to finance government ...
Trading Center